There have been arguments that traders have now prepositioned portfolios, and happy to drift into the menagerie of central bank speakers this week. There is logic to that, but we see buying in the Hang Seng (+0.8%) and the ASX 200 (+0.4%), and interestingly, volumes are 64% above the 30-day average (for this time), while 64% of stocks are higher. Perhaps put that down to further weakness in the AUD boosting health-care, and a dovish set of RBA minutes keeping the consumer names bid.

Equity indices in Japan (-0.3%) and China (+0.1%) perhaps hold a tighter line, and it certainly feels like the calm before the storm, with traders focusing most intently on the USD, interest rate pricing and front-end bond yields. This is our chance to mark-to-market the current aggressive rates pricing, and all that is going on in the world of economics and deteriorating inflation expectations and to see if the Fed are on board with this view. Recall, the market can be a fragile beast at times and needs to hear exactly what it wants to hear.

(Purple – US 5y5y breakeven inflation expectations, yellow – US 5y inflation swaps, white – Uni of Michigan 5-10yr inflation expectations)

(Source: Bloomberg)

We head into European trade, where at 18:00aest (9 am BST) the master dove, Mario Draghi, will get an opportunity for his rebuttal at former IMF economist, Oliver Blanchard, who started the Sintra conference with commentary that will resonate with many. Mr Blanchard’s view that the ECB lacks the armoury to support the European economy, should we see a recession, is a theme that has been discussed for a while. It is something Mario Draghi will be keen to address and convince the market that the ECB still have the control to achieve their desired monetary targets. The focus here has been on the sharp decline in EU inflation expectations, which found little support from a reasonable uplift in EU labour costs, and that has to concern, to the point that traders will be hanging off Draghi’s every word. Assessing the urgency and willingness that the bank can and will do more, and by more, we mean resume QE in the months ahead.

The EUR and German bunds, therefore, are our guide over the next 12-hours, and what’s interesting is that despite dovish commentary yesterday from ECB members De Cos and Coeure, the EUR is failing to attract broad sellers. This could change, but the bullish breakouts for the EUR against GBP, NZD, AUD suggest traders are not overly concerned that Draghi will cause a lasting reversal. Certainly, the move in EURAUD today above 1.6400, has been premised on a broad AUD sell-off today, with the RBA giving us the clarity that more easing is likely in its May minutes (at 11:30aest).

Music to AUD bears ears then, and there are plenty of them around, and we all like it when the rates market and the central bank are on the same page.

EURGBP is a trend-followers dream right now and further eyeing a move into the 90-handle. Although, that is being influenced by the fact GBP is the ugly child of G10 currencies. A showdown between Boris Johnson and Jeremy Corbyn beckons, and the idea that we could see the British public decide Brexit’s destiny later in Q4. How do we buy GBP in that environment? It’s certainly very hard, and that is exactly what we see now, with the bid coming fully out of the market. Headlines in Asia that Chancellor Philip Hammond is “prepared to resign” over Theresa May’s spending plans are only fuelling the selling today, with GBP looking like it’s a matter of time before it cracks 1.25, with GBPCHF also looking heavy and continuing its bearish trend.

Commentary overnight from the British Chambers of Commerce that British businesses were cutting back on investment by the most in a decade (this year) have further fuelled GBP bears. For those concerned that Brexit could significantly weaken the UK economy are seeing evidence right here.

Of course, the big conversation remains fixed on the FOMC meeting, and the potential reaction in the USD and front-end US Treasury yields to what we hear, or what we don’t hear. The period on Thursday morning between 4 am, and 5 am (AEST) will be critical, so it promises to be an early start for many based in Asia-Pac. I am sympathetic to the view that the Fed, at the very least, need to change its guidance, to offer the flexibility that a cut in the July FOMC meeting is a strong consideration. Markets know when a cut is priced above 80%, that the central bank has to guide expectations with incredible skill or we are left incredibly disappointed and will show you the anger in a punchy reaction. It’s interesting that implied volatility in the USD pairs is so subdued, and take USDJPY for example; implied volatility (from Thursday) sits at a lowly 7.08%, which implies a 51-pip move (either side of the current spot price of 108.34). Hardly a market that is expecting big moves in price. Seems lowball to me.

Published by Chris Weston, Head of Research, Pepperstone